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How to Ensure Quality Health Coverage (Part 2)

In “Is Obamacare Harming Quality? (Part 1),”
I explain that new research shows that Obamacare is not working how
it is supposed to work in theory: The law’s preexisting
conditions provisions create perverse incentives for insurers to
reduce the quality of coverage; those provisions are reducing the
quality of coverage relative to employer plans; and the erosion in
quality is likely to accelerate in the future. In this post, I
explain why regulators cannot fix this problem, and why providing
sick patients secure access to quality health care requires
allowing consumers to purchase health plans not subject to
Obamacare’s preexisting conditions provisions.

The Challenge Of Risk Adjustment

Those provisions require insurers to charge high-cost patients
premiums well below those patients’ expected claims. They
therefore create an upside-down world where insurers that offer the
best coverage for the sick suffer the most losses: Whichever
insurer offers the highest-quality coverage attracts the greatest
number of patients who take out of the insurance pool more than
they contribute. This creates a perverse incentive for insurers to
make their coverage unattractive to the sick.

Obamacare’s risk-adjustment program attempts to provide
insurers supplemental funds to ensure that the price an insurer
receives for covering each high-cost enrollee matches the cost that
enrollee imposes on the plan. If risk adjustment sets the prices
too low, each insurer still faces incentives to make its coverage
for high-cost patients worse than its competitors’ coverage.
If it sets the prices too high, insurers will compete to capture
those excess payments by making their plans inefficiently
attractive to the sick. If risk adjustment gets the prices just
right, insurers have no incentive to attract or avoid the sickest
patients.

Every day that
Obamacare’s preexisting conditions “protections” remain mandatory,
more and more Americans develop expensive medical conditions that
should be insured conditions but instead become uninsurable
preexisting conditions.

Research by economists Michael Geruso of the
University of Texas-Austin, Timothy J. Layton of Harvard
University, and Daniel Prinz of Harvard University shows that
Obamacare’s risk-adjustment mechanisms are committing both
overpricing and underpricing errors. The latter errors are causing
coverage to get worse for all enrollees, but particularly those
with multiple sclerosis and other illnesses, and are likely to get
worse very soon and over time.

One Option: Assume A Can Opener

Geruso, Layton, and Prinz argue that when the risk-adjustment program
makes pricing errors, “The answer is to make the necessary
incremental improvements to the policies, not to scrap the ACA
entirely with its important and widely popular limits on premium
discrimination.” Interestingly, this argument assumes that
Obamacare’s preexisting conditions provisions are popular
when in fact polling consistently showsthe popularity of those provisions
disappears if they reduce quality—which Geruso, Layton, and
Prinz found they do. The principal weakness of this argument,
however, is that it ignores the difference between how government
price-setting works in theory versus reality.

In theory, a risk-adjustment program could constantly identify
and correct its pricing errors. When government price-setters find
evidence that prices are too low or too high, they need only make
the necessary adjustments.

Experience shows that that is not how government price-setting
works in practice. Looking just at health care, government
price-setting agencies persistently get the prices wrong, even when
they know the prices are wrong. Ubiquitous complaints from
researchers and others about overpayments in Medicare Advantage;
overpayments in Part D; overpayments for durable medical equipment;
Medicare favoring specialty care over primary care;
Medicare favoring procedures over time spent with patients;
Medicare’s inability to negotiate with drug companies;
site-of-service differentials; quality-blind payment; and so forth
are all complaints about the government’s inability to get
the prices right.

In Medicare and elsewhere, these pricing errors tend to persist
for years or decades because government price-setters face both
information and incentive problems. Central planners are not able
to collect enough of the ever-changing information on clinical
effectiveness, consumer preferences, availability of resources,
competing demands on resources, technology, and so forth to
determine the “right” prices for medical goods and
services (read: the prices at which marginal cost equals marginal
benefit, all marginal rates of substitution are
identical, God’s in his heaven, and all’s right
with the world).

Information problems make Obamacare’s underpricing errors
particularly intractable. Some patient traits that predict higher
claims, such as a preference for high-cost “star”
hospitals, are not observable. Since the risk-adjustment
program cannot observe such traits, it will always set prices too
low for such patients. Insurers cannot observe those traits ex
ante either, but they can make coverage worse for such patients, for example, by offering
increasingly narrow networks. And indeed, they
are.

Even when government price-setters do collect enough information
to identify pricing errors, in the vast majority of cases they
still can’t correct them. The reason is simple and also
intractable. Every dollar the government spends on excessive prices
is a dollar of revenue to somebody, and that somebody has a
lobbyist. Incumbent providers and other interest groups fight to
protect the overpricing errors that favor them, even at the cost of
preserving underpricing errors that affect less-powerful groups.
Congress faces incentives to please those politically powerful
incumbent providers, and government price-setters face incentives
to please Congress. So even if price-setting agencies are full of
omniscient, selfless public servants, Congress can and does
override them. The incentive problems facing government
price-setters are so great, many observers have proposed government
price-setting bodies that are quasi- or totallyindependent from Congress. Yet, an
unaccountable government agency may create even bigger information
and incentive problems.

To be clear, the problem is not just that government gets the
prices wrong. Markets get prices wrong all the time. The difference
is that market prices self-correct. Markets both take account of
more information and create incentives for everyone involved to
push market prices in the right direction. Government prices do not
self-correct, both because government agencies cannot collect as
much relevant information as decentralized market participants, and
political actors face incentives to preserve pricing errors.

The upshot is that the government’s record of setting
health care prices suggests that the pricing errors Geruso, Layton,
and Prinz identify will persist, as will other pricing errors that
inevitably emerge over time, such as from the expiration of the
reinsurance program. Experience suggests that there will be more,
not fewer, pricing errors eroding the quality of coverage available
to the sick.

How, then, can policy makers make quality coverage more
affordable and secure for the sick?

A Better Option: Incentive-Compatible
Insurance

Health systems are like marriages. They succeed only to the
extent that the participants actually want to be there. A health
system that enjoys the support of only one political party, or that
requires consumers, insurers, and government officials each to act
against their perceived self-interest, is unlikely to deliver
secure, sustainable access to high-quality care for the sick. A
more sustainable system is one in which the majority sees it as in
their financial self-interest to participate and that reserves
coercion only for those cases where voluntary cooperation
fails.

There is considerable evidence that a voluntary system of health
insurance—in which all parties want to be
there—continually strives to make access to care more
affordable and secure for those who develop expensive medical
conditions. It is no coincidence that it was in markets free from
guaranteed-issue mandates or community-rating price controls that
insurers developedinnovations such as guaranteed
renewability and preexisting conditions insurance. Guaranteed
renewability (as noted in Part 1) emerged as a response to virtuous
incentives to make coverage better for the sick, protected
enrollees from “risk reclassification” when they
developed expensive conditions, and provided more secure access to care than employer plans.
Preexisting conditions insurance made those protections available
at an 80 percent discount—at least, until Obamacare outlawed
both of these innovations.

Congress can make coverage more affordable and access to care
more secure by repealing or letting consumers opt out of
Obamacare’s preexisting conditions provisions and other
health-insurance regulations. A studyconducted by McKinsey and Company for the
Department of Health and Human Services estimated that the
preexisting conditions provisions are the primary reason
individual-market premiums are rising so rapidly. Repeal or an opt-out would free the
vast majority of exchange enrollees to purchase low-cost,
guaranteed-renewable coverage—or even lower-cost preexisting
conditions insurance—at any time of year. In addition to
greater freedom, those consumers would gain something else they
currently lack: sustainable, long-term protection against the cost
of illness.

A minority of exchange enrollees would be unable to find or
afford coverage at actuarially fair premiums. As a matter of
political reality, reform will include some form of subsidy for
this group. One option is a high-risk pool. High-risk pools
likewise exhibit quality and affordability problems—in
part because they too suffer from government pricing errors. Yet, a
voluntary insurance market combined with government high-risk pools
need not be perfect to outperform Obamacare. The more direct,
transparent, and equitably financed a high-risk pool’s
subsidies are, the more politically sustainable those subsidies
will be. Moreover, any imperfections of a high-risk pool are as
much a feature as a bug. To the extent that government pricing
errors lead to suboptimal quality in high-risk pools, they create
incentives for people to purchase insurance in the voluntary
market.

A proposal by Sen. Ted Cruz (R-TX) represented a true compromise
between the warring tribes. As originallyconceived, the Cruz compromise would allow
insurers to sell non-Obamacare-compliant plans, so long as they
continued to offer compliant plans to all comers. Exchanges would
essentially become high-risk pools. Subsidies to those with
preexisting conditions would become transparent. Healthy enrollees
could only obtain non-compliant plans if there were enough
political support for the level of subsidies necessary to entice
insurers into offering compliant plans. Most important, the
availability of guaranteed-renewable insurance would reduce the
need for government subsidies by providing a voluntary and thus
sustainable way to subsidize those who cannot afford the care they
need.

The Trump administration could achieve much the same thing
through executive action by redefining short-term health plans to
allow them to be guaranteed renewable. Such a step would free
consumers from all of Obamacare’s health-insurance
regulations, even federal health insurance regulations that predate
the Affordable Care Act. Creating a “freedom option”
through executive action, moreover, would not condition the
availability of non-compliant plans on the availability of
compliant plans, as the Cruz compromise would. If the Trump
administration proceeds with its plans to redefine short-term health plans,
Obamacare supporters may want to give the Cruz compromise a closer
look.

Conclusion

Obamacare’s compulsory system of health insurance creates
perverse incentives for healthy people not to contribute to the
medical bills of others, exacerbates incentives for insurers to
skimp on care for the sick, and creates incentives for the
government not to correct these and other errors. A voluntary
system of health insurance would not need to be perfect to do
better.

The clock is ticking. Every day that Obamacare’s
preexisting conditions “protections” remain mandatory,
more and more Americans develop expensive medical conditions that
should be insured conditions but instead become uninsurable
preexisting conditions. Congress and the president should act
before Obamacare makes coverage for the sick any worse.